Record-high prices at the pump, a looming diesel shortage right when the summer season is starting, and an uncooperative OPEC are probably reasons for many headaches among government officials around the world. Yet these are, in fact, manifestations of deeper problems in the energy industry.
Underinvestment In the past decade or so, Europe and, to a lesser but no less significant extent, North America, have made it their mission to reduce their reliance on fossil fuels and increase their reliance on renewable energy.
This has spurred an investor exodus from oil and gas and the emergence of the so-called ESG investing trend. Money for new oil and gas developments has become more difficult to tap as banks join the ESG movement, and companies have had to cut back on spending.
Saudi Arabia's oil minister warned that underinvestment in oil and gas would have a boomerang effect on consumers earlier this year, and he is not the only one. Many OPEC officials have made the same warning but, apparently, to no avail. After all, none other than the International Energy Agency said last year the world does not need new oil and gas exploration because we won't be needing any more new oil or gas supply.
Of course, it was only a few months later that the IEA changed its tune, calling on OPEC to boost production, and it demonstrated one of the harsh realities of the energy industry: you cannot reverse a process that has been going on for years in a matter of months.
Low discovery rates
A topic that doesn't get much talked about, the average rate of new oil and gas discoveries is, in a way, comparable to the average conversion rate of solar panels: it is well below 30 percent.
Bloomberg recently reported that three wells that Shell had drilled offshore Brazil had come up dry. The supermajor had paid $1 billion for drilling rights in the area and had spent three years drilling to come up empty-handed. Exxon had also failed to tap any significant oil reserves in its Brazilian blocks, which cost it $1.6 billion.
The news highlights the risky nature of oil and gas exploration even in places like Brazil, which has been touted as the next hot spot in the industry, probably alongside Guyana. Brazil has become a magnet for supermajors because of its prolific presalt zone, but, as one local energy consultant told Bloomberg, the big discoveries have already been made—back when the discovery rate was close to 100 percent.
The average successful discovery rate for the oil and gas industry is much lower than that, however, at 24.8 percent, according to Bloomberg. And there are fewer and fewer big discoveries to be made.
Production cost inflation
Broader inflation trends, in large part driven by soaring energy costs, have not passed the energy industry itself. In the U.S. shale patch, production costs have risen by some 20 percent. Two companies recently warned they would be reporting higher costs for their second quarters, Continental Resources and Hess Corp, and they are far from the only ones experiencing these higher costs.
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Shortages of raw materials such as frac sand and, earlier this year, steel piping for wells, are one reason for the production cost inflation, not just in the shale patch but everywhere where these raw materials are used in oil fields. A shortage of labor is a special problem for the U.S. shale patch, too, helping to drive production costs higher. Lingering supply chain problems from the pandemic are also in the mix.
The bigger problem is that the industry is not expecting any respite in the coming months, either, as Argus recently reported, citing oil and gas executives. The production cost squeeze comes at a time when the federal government really needs more oil and gas, which is probably the worst possible time as it has discouraged drillers further from spending more on new drilling.
Cyberattacks
Cybersecurity has become a cause for concern in the energy industry in the past few years as cyberattacks have multiplied significantly. The Colonial Pipeline hacking really helped out things in perspective on the cybersecurity front, but little action followed, it seems.
A brand new survey by DNV, the Norwegian risk assessment and quality assurance consultancy, revealed this week that the industry is quite uneasy about cyberthreats and, what's worse, not really prepared to handle them.
According to the study, 84 percent of executives expect cyberattacks will lead to physical damage to energy assets, while more than half—54 percent—expect cyberattacks to result in the loss of human life. Some 74 percent of the respondents expect environmental damage as a result of a cyberattack. And only 30 percent know what to do if their company becomes a target of such an attack.
Geopolitics
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The most chronic risk in the energy industry, geopolitics is never far away when prices start swinging wildly or, as is the case right now, remain stubbornly high. The prospect of an EU oil embargo on Russia, although dimming in the past few days, is one big bullish factor for oil prices. The lack of progress on Iran nuclear talks is another. And then there is, of course, OPEC's evident unwillingness to respond to calls from the West for more oil.
Russia itself does not seem bothered by the embargo prospects at all. "The same oil that they [the EU countries] bought from us will have to be purchased elsewhere, and they will pay more, because the prices will definitely rise; and once the cost of delivery and freight increase, it will be necessary to invest in building the corresponding infrastructure," Deputy Prime Minister Alexander Novak said this week.
Iran is meanwhile boosting its oil exports, which go almost exclusively to China. The country has signaled it will not agree to a deal with the U.S. unless the U.S. meets its demands, and it appears that the ball is now in Washington's court. In the meantime, China will have Iranian oil, but no one else will.
For the U.S., the price problem has become so dire that now President Biden is seeking a meeting with the Saudi Crown Prince Mohammed, whom he has consistently refused to communicate with, instead communicating with his father, King Salman. Biden has also been openly critical of MbS for his alleged role in the killing of a dissident Saudi journalist, calling the Kingdom a "pariah" with "no redeeming social value." Geopolitics can be awkward.
By Irina Slav for Oilprice.com
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Underinvestment was happening before the pandemic came on the scene as a result of calls by the environmentalists, the IEA and the EU on the global oil industry to divest its oil and gas assets and and stop investing in fossil fuels. So they have themselves to blame for the skyrocketing energy prices, galloping inflation and incoming recession.
What is called for now and immediately is a spending of at least $600 bn a year for the next ten years to expand production capacity of oil and gas to meet global demand otherwise the world will face the worst energy crisis in its history precipitating a serious food crisis and starvation in many parts of the world.
Low discovery rates of both oil and gas are a function of technology and costs of production. It is a fact that oil discoveries peaked in 1965. What is being discovered nowadays is small reserves which are in most cases very costly to produce. Still, small discoveries could fill a gap in the depleting energy supplies.
And with rising energy prices, one would expect that inflation and costs of production will continue to rise in coming years. However, I hasten to add that low discoveries and rising costs of production are overwhelmingly caused and also determined by underinvestment.
In a world divided by two blocs, cyberattacks are an integral part of geopolitical warfare. It will afflict every single part of the world and will also add to costs of production in general since a lot of money will have to be spent on anti-cyber attacks.
Geopolitics is one side of energy. The other is economics and the two sides are inseparable. It has direct impact on energy prices and supplies. The only consolation is that its impact is often short-lived and transient. The latest example is the Ukraine conflict which hasn’t so far caused physically any energy supply disruptions. Even the Ukraine price premium which at one point added $30 to a barrel of oil has now fizzled out leaving prices to market forces.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London